Jul. 25, 2013
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Steven Cohen / Jenny Boyle, PR Newswire

by Kevin McCoy and Tim Mullaney, USA TODAY

by Kevin McCoy and Tim Mullaney, USA TODAY

NEW YORK - On many Sunday evenings, billionaire SAC Capital Advisors founder Steven Cohen phoned or met in-person with his top portfolio managers, ensuring he got their latest trading ideas before the financial week began.

Cohen's nationally famed hedge fund and its affiliates, among Wall Street's largest and most profitable, also funneled him updates from the financial lieutenants via voice mail and e-mail boxes specifically set up to collect trading strategies.

Many of those calls, meetings and strategies formed the basis of illegal insider trading in an alleged 1999-2010 scheme that involved stock in at least 20 companies and profits totaling hundreds of millions of dollars, according to a five-count criminal fraud indictment announced Thursday by federal prosecutors. The indictment, the most significant in a series of high-profile government attacks on insider trading, could cripple the nationally renowned fund - though the firm and its affiliates said they would remain in operation while challenging the charges.

The 41-page indictment and prosecutors depicted a corporate structure and culture in which Cohen sat at the center of a web of portfolio managers and research analysts, systematically collecting and trading on information he should have suspected was illegally gathered from employees of publicly traded firms such as Intel, Dell and Yahoo.

But seemingly lacking sufficient direct evidence against Cohen, one of the nation's wealthiest individuals, the government, at least for now, opted to proceed in court with charges against his companies, but not the founder and chief guiding force himself.

Citing numerous examples of "institutional indifference" to the alleged unlawful conduct, the indictment charged that the trading scheme "was substantial, pervasive and on a scale without known precedent in the hedge fund industry."

Along with the criminal charges of wire fraud and securities fraud, federal prosecutors filed a civil forfeiture complaint seeking to recover illegal gains from insider-trading offenses. The complaint also seeks to impose money-laundering penalties against the hedge fund and its affiliates for allegedly commingling insider-trading profits with other cash in the funds.

Richard Lee, an SAC portfolio manager responsible for directing a $1.25 billion "special situations fund," pleaded guilty to insider-trading charges Tuesday in the years-long SAC Capital investigation, said the Manhattan U.S. Attorney's office as prosecutors unsealed his plea. He became the eighth former SAC Capital employee to be charged or convicted on such charges.

The Securities and Exchange Commission on Thursday separately announced a civil insider-trading complaint against Lee that alleged he generated more than $1.5 million in illegal profits.

The cases represent the hardest in a recent series of major legal blows for Cohen, who gained riches from the funds, which he has continued to use as an investment and trading vehicle for his personal fortune.

The allegations also land another black eye on Wall Street, which has already been rocked in recent years by the insider-trading convictions of billionaire Galleon Group hedge fund manager Raj Rajaratnam and former Goldman Sachs director Rajat Gupta.

According to the indictment, portfolio managers and research analysts "engaged in a pattern of obtaining inside information from dozens of publicly traded companies across multiple industry sectors." The company allegedly:

â?¢ Sought to hire portfolio managers and analysts "with proven access to public company contacts likely to possess inside information."

â?¢ Gave portfolio managers financial incentives to give Cohen recommendations about "high conviction" trading ideas in which they had an "edge" on other investors. But the managers weren't "questioned when making trading recommendations that appeared to be based on inside information," the indictment charged.

â?¢ Failed to use effective compliance procedures or practices to prevent portfolio managers and analysts from engaging in insider trading. SAC managers on several occasions failed to refer suspicious trading recommendations to the company's compliance department for investigation, the indictment charged.

The portfolio managers and research analysts "were required to share their best investment ideas with the SAC owner" - Cohen - "while indications that those ideas were based on inside information were often ignored" by the funds' management, the indictment also alleged.

"The relentless pursuit of an information 'edge' fostered a business culture within SAC in which there was no meaningful commitment to ensure that such 'edge' came from legitimate research and not inside information," the indictment charged. "The predictable and foreseeable result ... was systematic insider trading ... resulting in hundreds of millions of dollars of illegal profits and avoided losses at the expense of members of the investing public."

"When so many people from a single hedge fund have engaged in insider trading, it is not a coincidence," said Manhattan U.S. Attorney Preet Bharara, referring to the eight charged or convicted. He described SAC Capital as "a company with zero tolerance for low returns but seemingly limitless tolerance for insider trading."

Asked whether prosecutors would seek a separate indictment against Cohen, Bharara said, "I'm not going to say what tomorrow may or may not bring."

Responding to the charges, the hedge fund group said in a formal statement that "SAC has never encouraged, promoted or tolerated insider trading and takes its compliance and management obligations seriously.

"The handful of men who admit they broke the law does not reflect the honesty, integrity and character of the thousands of men and women who have worked at SAC over the past 21 years. SAC will continue to operate as we work through these matters," the statement concluded.

Citing assurances from prosecutors, the company said there were no plans to freeze assets of the hedge fund or its affiliates. The government action is not intended to block investor redemptions, affect the interests of the funds' trading counterparties or hinder ongoing business operations, the company said.

Nonetheless, legal and financial experts said the the indictment could speed a recent investment outflow from SAC Capital. Until recent months, the fund held an estimated $15 billion. "There's a great likelihood they will continue to lose investors," said Stuart Slotnick, an attorney who chairs the business litigation practice at Buchanan Ingersoll & Rooney in New York.

If SAC Capital is hit with redemption requests from worried investors and is forced to sell trading positions, other hedge funds could try to trade against the firm and take advantage, said Steven Nadel, a partner in the hedge fund group at law firm Seward & Kissel in New York. Maintaining adequate levels of cash, or liquidity , is critical, as is "protecting the value of the assets," he added.

There's nothing in the law that would stop SAC Capital from continuing operations while challenging the charges, said Jacob Frenkel, a former federal prosecutor who heads the securities law practice at Shulman Rogers Gandal Pordy & Ecker in Potomac, Md. "The challenge is why investors would want to throw funds into an investment pot that could become the subject of a forfeiture action," he warned.

Frenkel also noted that former accounting giant Arthur Andersen, one of a handful of major U.S. firms specifically targeted with federal criminal charges, ultimately won a Supreme Court appeal of the case against it. "But it was a hollow victory, as the company was devastated at that point," he said.

Richard Holwell, the former federal judge who presided at the Rajaratnam trial, said the government case against SAC Capital appeared to be based on showing that the company's portfolio managers and other top officials - if not Cohen himself - knowingly acted with fraudulent intent.

"The government doesn't have to show Cohen's state of mind," provided it presents evidence showing the state of mind and bad intent by other top officials, said Holwell, who's now in private practice at Holwell Shuster & Goldberg in New York. Former SAC Capital portfolio managers should qualify as top officials because they had been in charge of millions of dollars in trading for the funds, he said.

Prosecutors will need to convince a jury that SAC's decision to look the other way was so flagrant that it rose to the level of criminal conduct, said Stephen Crimmins, a former SEC deputy chief of enforcement litigation who now is at K&L Gates in Washington, D.C.

SAC is likely to counter by highlighting the amount of staff and technology it devoted to compliance with legal and trading standards, predicted Crimmins.

The widely anticipated criminal charges come after SAC Capital and CR Intrinsic, another Cohen affiliate, recently agreed to pay the SEC a record $615 million in penalties to resolve civil insider-trading charges against the firms.

Additionally, the SEC on July 19 filed civil administrative charges against Cohen himself, alleging that he "failed reasonably to supervise" two senior portfolio managers who themselves have been been hit with insider-trading charges and are awaiting trial.

Like the new criminal case, the civil action didn't accuse Cohen himself of insider trading. But a government victory could ultimately bar Cohen from handling investor funds and further involvement with the securities industry.

In the civil case, the SEC alleged that Cohen received "highly suspicious" non-public information in 2008 from then-portfolio managers Mathew Martoma and Michael Steinberg, who have pleaded not guilty in their cases. The allegations involved stock trading in pharmaceutical firms Elan and Wyeth, as well as in computer giant Dell.

Instead of heeding his supervisory responsibility to investigate, the SEC charged that Cohen "ignored red flags" and allowed trading on the information to proceed, thereby earning profits and avoiding losses totaling more than $275 million.

Disputing the charges, attorneys for Cohen have said he "had every reason to believe" that one of the portfolio managers relied only on public information and that the hedge fund founder didn't read a crucial e-mail sent by the other manager.

The civil case against Cohen is scheduled to begin with an Aug. 26 hearing before SEC Chief Administrative Law Judge Brenda Murray.

John Coffee, a Columbia University law school professor expert in securities law last week said it's relatively rare for the SEC to bring such a case as an administrative proceeding, rather than in federal court.

The move potentially gives the SEC "home court advantage," said Coffee, because the rules of evidence are somewhat less strict than in federal court and could enable the agency to introduce more hearsay evidence.